Most W-2 employees' pay stubs detail the taxes and deductions that are taken from their gross pay. You'll almost certainly see two items among these deductions, in addition to federal and state or local income taxes: Social Security and Medicare taxes. These taxes are part of the Federal Insurance Contributions Act (FICA) tax, a group of payroll taxes that are collected from both the employer and the employee.
An Additional Medicare Tax can be deducted from some employees’ pay as well. After federal and state income taxes, Social Security and Medicare, or FICA taxes, make up the bulk of taxes that are routinely withheld from your paychecks.
How FICA Taxes Are Paid
You, the employee, pay half the FICA taxes, which is what you see deducted on your pay stub. Your employer must match these amounts and pay the other half to the government separately at regular intervals.
Independent contractors don't have FICA taxes—or income taxes—withheld from payments made to them, but they must nonetheless pay them. They must pay both halves of Social Security and Medicare as the self-employment tax.
Social Security and Medicare Tax Withholding Rates and Limits
|Tax||Withholding Rate||Exempt Earnings|
|Social Security tax||6.2% paid by employees||Over $137,700 in 2020|
|6.2% paid by employers||Over $142,800 in 2021|
|Medicare tax||1.45% paid by employees||No earnings exempt in 2020|
|1.45% paid by employers||No earnings exempt in 2021|
|Additional Medicare Tax||0.9% paid by employees||Earnings to $200,000 in 2020|
|No employer contribution||Earnings to $200,000 in 2021|
Employees are no longer required to pay the Social Security tax in a given year when their earnings hit the contribution and benefits base, often referred to as the “taxable minimum.” You—and your employer—would pay the Social Security tax on only the first $142,800 in 2021 if you earned $143,000, for example. That remaining $200 is Social Security tax-free.
The Social Security tax will apply again on January 1 of the new year until your earnings again reach the taxable minimum.
The Medicare taxes work somewhat in reverse. All income is subject to Medicare taxation, but the Additional Medicare Tax does not apply until after your income reaches a certain threshold: $200,000 in 2020 and 2021.
Where Social Security Taxes Go
The bulk of the FICA tax revenue goes to funding the U.S. government's Social Security trusts. These trusts are solely designated to fund the programs administered by the Social Security Administration, including:
- Retirement benefits
- Survivor benefits
- Disability benefits
The Social Security tax revenue that's collected from wage earners and employers is placed into these trusts, which in turn fund the monthly benefits to these individuals:
- Retirees and their spouses who have qualified for Social Security (retirement benefits).
- Surviving spouses and minor children of workers who have died (survivor benefits).
- Disabled workers (disability benefits).
Costs associated with administering the plan also come directly from these trusts, but they're minimal: Less than one cent out of every dollar collected pays for administrative costs, according to the Social Security Administration.
The taxes collected can exceed the cost of current benefits. The money is put in the trusts and invested to pay for future program benefits when this occurs.
Investments made from the funds placed in these trusts allow the federal government to essentially borrow against the surplus to fund other parts of the government. This practice has many worried about the longevity of these Social Security programs, but the government has repaid its loans from the Social Security trusts with interest so far.
Where Medicare Taxes Go
The remainder of FICA tax money collected from your paycheck and from your employer goes to the Medicare program, which funds healthcare costs for older people and younger Americans with disabilities. The Medicare taxes collected from current wage earners and their employers are used to pay for hospital and medical care costs incurred by current Medicare beneficiaries. Any excess tax revenue is accounted for in a designated Medicare trust fund.
Unlike Social Security, Medicare is also financed through premiums and from the government's general revenue, so it's not wholly dependent on the collection of FICA payroll taxes.
The Additional Medicare Tax
The Additional Hospital Insurance Tax, more commonly referred to as the Additional Medicare Tax, is provided for by the Affordable Care Act (ACA). It became effective on November 29, 2013.
The purpose of this tax is to fund the provisions of the ACA as well as the Premium Tax Credit that went into effect under the ACA, and it was implemented with the express purpose of doing so. It works out to a rate of 0.9%, and employers do not have to match it, but it's not applicable to all taxpayers.
Only those with incomes that exceed $200,000 annually are subject to this tax as of 2020 and 2021.